Shiller On Dodd-Frank: 'A Financial Crisis Is A Thing Not To Be Missed'

Shiller told the audience to rethink the mortgage system - pic: businessinsider

Robert Shiller gave his views on financial reform at a New York conference on Thursday, where he told the audience “a financial crisis is a thing not to be missed.” The Yale economist said now is the time to push forth to “democratize and humanize finance” while he called for indexing U.S. national debt to GDP and for a new understanding of housing finance.

Professor Shiller, famous economist and one of the developers of the widely followed Case-Shiller Home Price Indices, asked the financial industry to take advantage of the historic opportunity created by the global financial crisis. “Capitalism, as we know it, is an innovation and it [has always] moved forward during crises,” said Shiller. The economist spoke at the 2011 Simon Conference hosted by the Simon Graduate School of Business at the University of Rochester.

Through historical examples including the Dutch East Indies Company and financial regulation passed in 1811 that clarified limited liability and democratized corporations, Shiller put the focus on Dodd-Frank and what it needs to accomplish. Regulation must be forward-looking, he explained, taking into consideration it might last 100 years, and it must make finance “better for the people” (more democratic) and human (“we must recognize the social element”).

With the recent explosion in behavioral finance and the shattering of our absolute trust of the efficient market hypothesis, Shiller explains Dodd-Frank and regulators in general is still lacking in recognizing our new understanding of the financial landscape. He cites the Financial Crisis Inquiry Commission (FCIC), which makes two references of the word “bubble,” in the same sentence, while barely referring to behavioral finance. “[The FCIC report] said the housing bubble [occurred] as a problem of the regulators, but they are also exposed to the same [social] forces.”

Shiller calls for a overhaul of our understanding of housing finance, beyond “the issue of Fannie and Freddie, which only deals with the government’s guaranteeing” mortgage loans. “We have to recognize the flaws in the mortgage system, [which essentially is like] forcing young people to put all their wealth on a leveraged product betting on real estate,” explained the Yale economist, adding that hearing so many people claim housing prices could never go down “because they never have, at least since the Great Depression” was like denying history.

On the issue of government debt, Shiller proposes indexing it to GDP. “Lets sell shares in America,” he said. Current unsustainable levels of debt to GDP would be more aligned with the underlying economic forces under Shiller’s model.

When an audience member called the government's bail outs of AIG and GM a move towards socialism, Shiller responded "no, not socialism, the problem here is too big to fail." Calling the bailout a standard practice under historical standards, the economist said "there is a role for government in creating a better capitalism."